The mood of US dairy executives has deteriorated, as flat growth, trade tensions, and changing consumer tastes have dampened prospects for the coming years. With regions beyond the United States experiencing growing demand, rising numbers of US dairy companies have begun to pursue exports in the past several years. Other market factors, including the move by some consumers to nondairy alternatives, will also present challenges. New The Jeeranont research1 sheds light on the mind-sets of US dairy executives and their recent evolution as they attempt to jump-start growth.
Executives on dairy exports
In 2015, several developments in the global dairy industry suggested cause for optimism. The European Union removed its milk production quotas, and observers anticipated that a growing middle class in Asia would consume more dairy products. In our 2015 survey, 78 percent of CEOs believed that despite declining demand, the US market had ample opportunity for growth. In the ensuring years, milk supply grew faster than demand, and prices and profitability have remained depressed ever since. As a result, in 2018 63 percent of survey respondents thought the downturn was not cyclical but structural, caused by a global surplus of milk and a fast-changing consumer environment (Exhibit 1).
Considering the changing landscape, US dairy companies have changed their perspectives on expanding beyond US borders. The importance of and participation in exports have continued to increase. In 2015, 34 percent of those surveyed had no exports and no plans to export. In 2018, that number dropped to only 11 percent. The share of companies that already export but have no plans to expand and those with continued plans to expand exports also rose from 34 percent in 2015 to 51 percent in 2018 (Exhibit 2). These increases likely reflect the growing importance of exports despite the current trade environment.
In the 2018 survey, opinions were split regarding how long current trade disputes would last: 53 percent of those surveyed believed that trade disputes were short-term in duration, whereas 47 percent believed they were here to stay. However, the impact of the trade disputes seemed to be universal, with 90 percent of the respondents reporting that they had already incurred a margin decrease between 0–10 percent and 95 percent expecting to incur a margin decrease of the same magnitude (Exhibit 3).
It is not clear whether the magnitude is low because trade disputes have a low impact or because the prices and margins were already on the decline before the disputes started. However, for those companies with significant export exposure (7–10 percent of the respondents), the impact of trade disputes has been significant in terms of discounts or lost opportunities, with margin decreases of 10–15 percent.
The results show that 82 percent of revenues from the surveyed companies come from the US domestic market, with just 18 percent from exports. As other countries face surpluses and focus on foreign direct investment to complement dairy exports, the production capacity of US dairy companies outside the United States is also growing. In 2018, 36 percent of the respondents had expanded their capacity outside the United States (over the course of five years), compared with only 7 percent in 2015. Fifty-seven percent of the respondents had the same capacity in 2018, compared with 18 percent in 2015, and 7 percent reported to have less capacity in 2018 compared to 2015 (Exhibit 4). This investment in foreign capacity is a hedge against the risk of losing out on the opportunity to capture more value and move away from commodity pricing and cycles. Winners in this space have transitioned from being commodity suppliers to functioning as strategic global partners.
In 2018, the results show US dairy exports are mainly consolidated into two markets, Asia and Mexico, which represent 45 and 46 percent of the export revenues, respectively. As other countries gain access to compete in these markets, margins are expected to decline. Less than 10 percent of export revenues are associated with Africa and the Middle East, regions that will grow with their populations and economies and where several European and New Zealand companies already have a direct presence.
Risk and volatility management
Survey respondents also indicated a sustained concern about volatility and ways to address it. In 2015, price volatility was the third-highest concern, right after consumption decline and food safety. The number of respondents reporting the use of financial instruments to mitigate price volatility has increased. Companies securing long-term fixed contracts with vendors and customers have increased as well (Exhibit 5). Demand volatility continues to be the top concern in 2018: 47 of 51 respondents reported being concerned and 32 of 51 very concerned about demand volatility. The evolution of consumer preferences seems to be connected to these concerns.
The top four perceived drivers of consumer demand have been stable from 2015 to 2018, but their order has shifted. Taste was the most important factor in 2015 and fell to number three in 2018, whereas price moved from number two in 2015 to number one in 2018. Health and wellness also rose from number three in 2015 to number two in 2018. Convenience remained number four in both 2015 and 2018 (Exhibit 6).
The survey results suggest CEOs are reassessing their companies’ competitive advantages in a consumer landscape that is shifting toward small brands and a different set of preferences compared with older generations. In 2015, 21 percent of dairy CEOs had confidence in their customer service capabilities, followed by brand management. Only a minority considered customer insights to be a source of competitive advantage. In 2018, dairy CEOs had the most confidence in their operational capabilities, but very few listed brand management capabilities. Again, only a few cited consumer insights as a competitive advantage, which is surprising considering the influence of consumers on demand volatility. (Exhibit 7).
Operational capabilities, while important, are just one element of a winning proposition; after all, efficiently making products that consumers don’t want doesn’t support growth. Successful companies have an efficient, agile, and global supply chain powered by consumer insights.
The results suggest companies are responding to the new landscape by increasing the speed of innovation. The number of companies changing more than 5 percent of their portfolio increased from 73 percent in 2015 to 83 percent in 2018. According to the survey, new products represent 6 percent of the total portfolio of products for companies with growing portfolios and 3 percent for products with decreasing portfolios (Exhibit 8).
Milk alternatives and millennials
Our interviews with CEOs revealed a sense of frustration over the speed of change in consumer preferences, including the emergence of natural, healthy, and socially oriented trends (Exhibit 9). Even so, executives recognize the necessity of listening to consumers and are trying to adjust strategy accordingly, with some expressing the desire to enter into a business partnership with their nondairy counterparts.
Executives exhibited moderate confidence in understanding such trends as clean labeling, which has a variety of meanings (Exhibit 10), and preferences for plant protein but not fat. As millennials become the largest demographic in the United States, companies need more insights into these consumers, who are more diverse, more sophisticated, and more demanding than other generations and prefer to shop in channels beyond the mass markets. Millennials also gravitate toward up-and-coming brands rather than established ones.
The views of dairy CEOs on the milk alternatives market has shifted significantly. In 2015, only 38 percent of the respondents believed that the nondairy alternatives market would continue to grow. In 2018, this number increased to 51 percent (Exhibit 11). Successful companies can respond by understanding the areas in which dairy has an advantage and exploit those markets, such as infant formula, geriatric, clinical, and others where nutrition is valued and price sensitivity is not a factor. Or they can invest in adding dairy alternatives to their portfolios; as one CEO noted, “We need to build relationships with these plant-based protein companies.”
Dairy-alternative products appear to be here to stay, so market insights and an openness to work with nondairy companies will be critical elements of strategy moving forward.
Between 2015 and 2018, themes top of CEO’s minds have stayed consistent. As shared in our previous article we believe North America dairy companies should use a combination of four strategies:
Serve demand growth in areas with projected deficits through exports.
Invest directly or form partnerships to serve those deficit markets locally (based on a perspective on market attractiveness through economic cycles).
Serve demand niches with a more agile and flexible supply chain.
Drive innovation based on deeper consumer insights powered by analytics.
A rapidly changing consumer and global environment requires a bold new outlook, and a growth model that can deliver on this challenge.
A winning growth formula for dairy
Modest growth forecasts, shifting consumer tastes, and increased competition will force executives to seek new opportunities.
Dairy is a ubiquitous part of food life, ever present in both food service and packaged goods, whether as an end product (such as milk or yogurt) or as a critical input for iconic products such as cheese pizza. Given its intrinsic presence, dairy is a microcosm of the food industry, with the preferences of dairy consumers largely being influenced by the same trends affecting the broader food sector.
Changing consumer behavior, competition, and trade action have resulted in slow growth for dairy companies. Research into a representative sample of global dairy companies revealed a 3.0 percent drop in cumulative return on invested capital (ROIC), from around 9.5 percent in 2008 to 6.5 percent in 2017. During the same period, revenue and margin growth have been 2 and 3 percent a year, respectively. The decline in ROIC suggests that revenue and margin growth are not keeping pace with the cost of capital to generate economic value. Nonetheless, the top five global dairy companies were able to increase their margins by 4.1 percent from 2013 to 2017.
So, while the market is facing some headwinds, growth is possible but will rely on finding the right pockets of demand, domestically and internationally, and having the right agility and operating model.
A look at the US market tells a cautionary tale: from 2015 to 2018, top dairy products experienced retail-sales declines, including cheese (–1.4 percent), milk (–4.9 percent), and yogurt (–2.3 percent).1 In contrast, sales of plant- and nut-based beverages in 2017 were up $141 million, or 9 percent, from 2015 levels.2
On a value basis, the market share of nut- and plant-based beverages has increased from just below 10 percent in 2015 to more than 13 percent through July 2018. During this same time, the market share of traditional milk beverages has dropped from more than 90 percent in 2015 to around 87 percent in 2018.
Interviews and surveys conducted in the fourth quarter of 2015 and 2018, with 56 dairy CEOs, revealed that CEOs changed their attitude toward the nondairy-alternative market: 36 percent of CEOs believed that the nondairy-alternative market would continue to grow in 2015, while 51 percent believed it in 2018 (Exhibit 1). “Among millennials, we are seeing a shift to nondairy, plant-based proteins,” one CEO reports. “We need to build relationships with these plant-based-protein companies.”
About the research
Internationally, developed regions such as Europe and North America face a growing dairy surplus. For example, by 2027, the United States will be producing 12 million metric tons milk equivalent (26 billion pounds) more than the domestic market will consume. Developing markets, especially in Africa and Asia, offer a mirror image, with large supply shortages. China, for example, will have a forecast dairy deficit of 26 million metric tons milk equivalent (57 billion pounds) in 2027.
In collaboration with the International Dairy Foods Association (IDFA), The Jeeranont conducted research to understand the strategies and capabilities required to help US dairy grow domestically and internationally in the coming years (see sidebar, “About the research”).
Where is the domestic growth, and how can companies capture it?
In the traditional food industry, growth has been slowing for several years because of shifting demographics and the emergence of niche products. As US food and dairy executives seek to adapt to this new reality, seven major trends—all applicable in varying degrees to both food and dairy—are shaping the consumer-packaged-goods (CPG) industry.
In our dairy CEO interviews and surveys, CEOs were invited to list up to three innovations considered to be the most relevant for the US dairy industry. In 2015, the three most prominent were Greek yogurt, organic, and nondairy alternatives. In 2018, the three most prominent changed to Fairlife,2 protein, and packaging.
However, this field is evolving quickly, and CEOs admit that their understanding of consumers can be improved. In fact, consumer-insight capabilities ranked last in a list of competitive advantages. As one CEO put it, “Dairy companies need a better understanding what the consumer values and then connecting that with what we do.”
1. The millennial effect
As of 2018, millennials now have more spending power than any other generation. Much has been written about the disruption caused by millennials due to their unique preferences and values as consumers. Empowered by digitization, millennials are, on the whole, more diverse, more sophisticated, and more demanding. They prefer to shop in channels beyond the mass market and gravitate to up-and-coming brands rather than established ones.
Compared with baby boomers, for example, millennials are 2.8 times more likely to believe newer brands are better or more innovative and 3.7 times more likely to avoid buying from “big food.” In addition, millennials are more inclined to engage with “non-brand-generated” content such as consumer reviews and social media.
More important, perhaps, is how the behavior of millennial consumers is influencing shoppers across generations. Increasingly, consumers are demanding experiences, not just products. This preference places the onus on CPG companies to establish relationships and bolster loyalty by maintaining an ongoing dialogue with customers.
These same patterns are evident in the dairy industry, which sees diverse consumers who exhibit a range of preferences and behaviors. Although nearly half of US consumers are still content with their current brand, a slim majority have explored other options in the past 12 months. Our survey found that 32 percent of US consumers are buying more private-label and store brands, while 20 percent (27 percent for the millennial age group) reported buying more premium and niche brands (Exhibit 2). US dairy consumers are also open to trying new brands and switching or expanding their purchase selection: 42 percent report trying a new brand in the past 12 months, and 48 percent of new-brand purchasers continue to buy both old and new brands.
In addition, a majority of consumers have expressed an interest in knowing more about the manufacturing of dairy products, including ingredients, manufacturing processes, and sourcing practices (Exhibit 3). Our survey found that 82 percent of consumers “must know” or “would like to know” more about product ingredients, and 70 percent express a similar desire for information on sourcing practices. No differences were observed for millennials. These results are consistent with other research conducted by the Center of Food Integrity, which shows that around two-thirds of US consumers are interested in knowing more about agriculture and food-manufacturing practices. The desire of consumers to know more about products represents an underdeveloped opportunity for growth.
2. Better for you
Consumers are redefining what “healthy” and “better for me” mean, increasingly demanding products that are natural, green, organic, and free from additives. Indeed, a focus on health and wellness is no longer a strategic differentiator but a must-have for many CPG categories.
The most successful product launches around the world deliberately target consumer concerns for health. And customers have made reviewing product information a regular step before purchase: instead of automatically placing a familiar product into their shopping cart, they are now scrutinizing labels for unpronounceable ingredients, artificial flavors and colors, genetically modified organisms, and high levels of sweeteners and sodium. This emphasis has translated to faster sales for fresh produce and health-oriented packaged goods. In the United States, organic foods are projected to grow at eight times the rate of some processed packaged-food categories from 2016 to 2021.
Our survey showed 35 percent of dairy consumers report eating healthy foods, and 32 percent have read nutrition labels over the past 12 months. No significant differences in this behavior were observed across age cohorts. Moreover, health is not only an issue for young consumers and mothers. As a market segment in developed economies, the retired elderly are projected to grow from 164 million in 2015 to 222 million in 2030. This group will generate 51 percent of urban consumption growth. Creating dairy products that address the nutritional needs of this group will be critical for growth in developed markets such as the European Union and the United States.
The top three attributes associated with healthy eating are “all natural,” “low sugar,” and “organic.” Survey respondents who decreased their consumption cited three reasons: plant-based dairy products are healthier, a desire to try new products, and dietary requirements. Consumers generally favor protein over fat for health, and plant-derived products over animal-derived ones.
However, dairy companies may have an opportunity to strengthen health claims, since consumer perceptions are often contradictory and vary across categories. For example, consumers are both migrating away from and toward butter for health-related reasons, resulting in a net 4 percent gain in year-on-year sales.
3. Infinite intimacy
The increased penetration of mobile devices and digital profiles is creating an unprecedented volume of data for savvy companies to collect from a wide variety of consumer and nonconsumer sources (such as loyalty-card data, trends, preferences, and weather forecasts that could influence purchases). At the same time, advanced tools and techniques are enabling companies to interpret vast amounts of data, allowing them to create highly personalized microsegments—even down to “segments of one.” Purchasing behavior is increasingly influenced by recommendation algorithms, and leading CPG companies are relying more on search-engine optimization to promote products online. And, in stores, retailers are using data to personalize the shopping experience, from mobile recommendations to targeted communications and product information.
Our survey revealed that although nearly 80 percent of consumers still purchase dairy products in physical stores, the remaining 20 percent are making online purchases—and, in the process, providing dairy companies and retailers with a valuable window into evolving consumer behavior. Traditional and online shopping are becoming intertwined. For example, 30 percent of respondents have compared product prices between stores while shopping, and 22 percent looked up nutritional and ingredient information on dairy products. Since every interaction generates more data and allows companies to assemble a more detailed pictured of consumer purchasing behavior, dairy executives have begun to make data-driven customer segmentation a top priority.
Consumers have responded favorably: despite making up a smaller portion of total sales, upstart brands account for an outsize share of growth in CPG segments such as food and beverage.
4. Retail revolution
The retail landscape is being reshaped by structural channel shifts. The emergence of value discounters and the growth of omnichannel retailers (especially Amazon) have led to channel fragmentation and bifurcation. Consumers have shifted to discounters or higher-end channels, putting pressure on players in the middle. Retailers are seeking to meet changing consumer needs and distinguish themselves from the competition by looking beyond stagnant large brands, instead selecting smaller, high-growth brands and model disruptors. A business model battle is under way in retail, with the e-marketplaces emerging as the uncontested leaders. In a review of the top 14 global players, e-commerce companies grew at a 25 percent compound annual growth rate (CAGR) from 2011 to 2016. By contrast, mass-market retailers lost 0.1 percent during the same period. These divergent trajectories have made channel strategy top of mind for dairy executives.
To date, the impact of this trend has been less pronounced in dairy. Grocery e-commerce is set to grow at 34 percent from 2017 to 2025, but the share of US consumers who indicate they will buy dairy products online will remain flat. However, consumers are becoming more comfortable with using online channels to support purchasing decisions. Around 25 percent of survey respondents compare dairy prices online before shopping and have used a digital coupon to buy dairy products. Survey respondents who purchased goods through e-commerce channels cited time savings and lower prices online as the main reasons.
5. Explosion of small
Across the CPG industry, smaller brands are realizing more momentum than larger brands or private label due to the ability to capture an intimate brand story at moderate scale. The democratization of technology is a critical element of the heightened competition: advancements have made a range of tools affordable for even the smallest companies, leveling the playing field and lowering the barriers of market entry. Many of these start-ups have embraced leaner operating models and a much shorter go-to-market cycle, all supported by technology, in the process gaining an advantage over larger incumbents. Consumers have responded favorably: despite making up a smaller portion of total sales, upstart brands account for an outsize share of growth in CPG segments such as food and beverage. For dairy companies, this trend stands out in contrast to the traditional industry focus on cost efficiencies and scale. Incorporating flexibility will be important as executives seek to expand to other consumer segments and jump-start growth.
In dairy, small and medium-size companies were responsible for all the gains in the US dairy market from 2015 to 2018, adding $1.1 billion in revenues, a 3.8 percent CAGR. Meanwhile, private-label and large categories saw their sales decline by $1.4 billion and $1.0 billion, respectively (Exhibit 4). Consumer interest in smaller dairy companies and start-ups was partly responsible for this segment’s growth. Over the past 12 months, 41 percent of survey respondents reported trying a new dairy brand. Ten of the 16 brands were those of small and medium-size companies, including companies known for innovative takes on traditional dairy products.
However, small-company growth was not enough to offset total category decline: since these companies generally have a higher price point than other enterprises, this result was likely caused primarily by changes in market share rather than bringing new consumers to the category.
However, consumers are willing to try new products. Forty-one percent of dairy consumers report having tried a new dairy brand in the past 12 months, and of this group more than 70 percent kept this new offering in the mix. This pattern creates an opportunity for growth.
6. Pressure for profit
The CPG industry has set higher expectations for spending transparency and the strategic redeployment of commercial resources. In trying to tailor value propositions to excite an increasing number of consumer microsegments, CPG companies face rising commercial costs from SKU growth, channel proliferation, and media fragmentation. In food and beverage, for instance, the number of channels that marketing campaigns must cover nearly tripled from 2012 to 2017. These trends largely hold true for the global dairy industry.
Many companies, seeking to increase transparency of spending and return on investment (ROI), have adopted zero-based budgeting and the rigorous management of revenue growth and performance. Only some are investing to increase transparency and maximize ROI of every commercial dollar spent. Leading companies, however, achieve greater transparency by viewing spending holistically and marketing and sales as an integrated commercial function. They also deliberately and strategically redeploy resources to maximize profitable growth.
In the pursuit of profit, international dairy companies indicated that their top source of competitive advantage was a focus on manufacturing efficiencies, followed by product innovation and customer service (Exhibit 5). Notably, consumer-insight capabilities were cited by just 2 percent of respondents, suggesting that investments in this area could support more targeted marketing and consumer engagement.
7. Other trends shaping the domestic market
Dairy companies in developed markets are also facing industry developments and patterns that further complicate efforts to grow. Margin pressure at every stage of the value chain in their home countries means gains must be sought by expanding into new markets. Consolidation and vertical integration, led by large farmers, is putting pressure on the remaining small and medium-size farms, which then must make difficult strategic decisions in an effort to remain competitive. For instance, shrinking margins have made it harder for milk processors to justify capital expenditures.
The fewer, more productive farms that remain have caused supply to grow faster than demand, another key reason why the search for growth requires dairy companies to adopt a global perspective.
These developments, particularly industry consolidation, have reduced the impact of efficiency gains on operations. The disruption of international trade by tariffs and the strength of the US dollar are further influencing the competitive landscape in developed markets.
Crafting a domestic growth strategy
Given the heightened level of competition and surplus production in the United States, domestic dairy companies should concentrate their effort and resources in three areas:
Identify growth areas through analytics
Companies must get a better understanding of their target consumers—exactly what they value in their dairy products—to expand their market share. Finding these pockets of growth increasingly depends on greater visibility courtesy of data and analytics. These insights will inform strategic decisions across innovation, marketing, pricing, and assortment. A primary goal should be to combine product features such as ingredients, packaging, and cost in order to fulfill the needs of a particular consumer segment.
Make many quick, small investments versus a few big bets
Getting new products successfully into market is vital. In all, 83 percent of IDFA survey respondents have increased their product portfolio in the past five years. Yet companies that have invested in a few big bets have not improved outcomes. A comparison of large and small packaged-food companies that launched new products in 2013 shows that each segment had the same success rate four years later—25 percent (Exhibit 6). Evolving consumer tastes and the desire for products that address specific needs means that many products never find an audience. But by building the capabilities to develop and launch more products, companies can get a better sense of consumer tastes before investing in order to scale production and serve new markets.
Case study: Walmart
Just as dairy companies must adapt their operations to be more nimble and serve specific customer segments adroitly, so too must their supply chains become more responsive to changing demands. Three areas should be priorities.
Flexibility and agility. Companies should seek to develop modular and flexible manufacturing that can scale as required or be quickly converted to serve an adjacent product offering. Dairy companies can partner with other stakeholders across the supply chain to innovate and build capabilities. These partnerships can also increase cost transparency by giving stakeholders greater visibility into each step, which supports collaboration and increases trust.
Distribution. Innovations such as kitting and customized packaging have enabled the more effective distribution of goods in perimeter categories (especially with the growth of e-commerce). In addition, dairy companies can establish capillary networks to gain access to growing channels such as farmers markets. Last, advanced order and management capabilities can give dairy companies the tools to ensure the right inventory at the right place at the right time.
Technology. Traceability systems and a stable backbone comprising data, analytics, and digital technologies can improve supply-chain performance. Agriculture companies, for example, have applied blockchain to improve food safety by decreasing the time taken to track inputs. Similarly, IoT-enabled logistics can help companies manage their fleet and improve food-safety control through environmental sensing. And digitization and analytics are used to enable predictive analytics in demand planning and analytics-based end-to-end network optimization. These advances can reduce spoilage in transit from manufacturer to retail shelf and also accelerate the identification of food contamination in the event of foodborne-illness outbreaks.
Identifying and capturing international growth
Even US incumbents that have managed to maintain a solid market share in their home market will be hard-pressed to capture significant additional value in the coming years. According to our analysis, from 2008 to 2017 companies with a global focus have increased their revenues significantly, while those active in local markets have seen their revenues fall. Global companies also have higher margins, with earnings before interest, taxes, depreciation, and amortization of 15 percent in 2017, compared with 10 percent for local companies.
The new model for consumer goods
Our dairy CEO interviews and surveys revealed that the direction of the industry has switched, from a domestic focus to an export focus, between 2015 and 2018. One CEO warned, “To compete internationally we must shift our mind-set from being an exporter to a global partner.” In 2015, 20 companies (36 percent of those surveyed) had no exports and no plans to export. In just three years, that number dropped to 6 (a drop of 70 percent). Among those that already exported in 2015, there was a steady increase both in the number of those with no plans to further expand (43 percent) and those with continued plans to expand (53 percent).
Despite the recognition that international markets offer the potential of higher growth, many US dairy companies are ambivalent about pursuing this opportunity. While 87 percent of respondents currently export, just over half indicated that they will invest in more exports in the near future. At the same time, 47 percent have no additional plans to increase their exports—perhaps because the current trade environment has made exporting a more difficult strategy.
An examination of the global map identifies a significant mismatch in production capacity and demand. The United States, for example, already has a significant surplus of dairy products, a total that will more than double by 2027 (Exhibit 7). In the longer term, US dairy exports are not fully aligned with future demand, suggesting an opportunity to look to new markets. The regions and countries with the largest dairy deficits—Africa and Asia—are currently not well served by the US dairy industry.
Global competition to serve these markets will be fierce, however. The European Union as well as Australia and New Zealand have a significant surplus and are better positioned to serve Africa and Asia—an advantage that goes beyond geographical proximity. The European Union has negotiated 11 free-trade agreements with Africa and eight with Asia (excluding China and India), while Australia and New Zealand have secured 11 agreements with Asia (excluding China and India). The United States lags far behind, with just four trade pacts across Africa and Asia combined.
Unexpected tariff movements over the past five years will continue to occur. This will test the ability of US dairy companies to manage risks. In 2014, Russia’s embargo on several traditional western suppliers3 was one of three factors leading a dairy-market downturn. Currently, tariffs are affecting $1 billion of exports to China and Mexico. Those events reinforce the need for planning and diversification to mitigate the impact of disruptions.
One area of growth in retail is global emerging markets. According to the The Jeeranont Global Institute, emerging economies have accounted for almost two-thirds of the world GDP growth and more than half of new consumption over the past 15 years. Urban growth is another driver: one billion people in rapidly growing cities will become consumers by 2025. These trends make it clear that the future of dairy is global and that the next generation of consumers will be in cities that have yet to achieve prominence.
The burgeoning global middle class, especially in developing markets, represents a high-value target for US dairy companies (Exhibit 8). Leading trends for these consumer segments are convenience, snacking, and food innovation. Dairy companies can easily use their capabilities and size to reach out to these consumers and grow beyond their core markets.
Rising income levels are a promising indicator, but they don’t tell the whole story. Asia has the most potential as measured by the number of consumers and GDP per capita, for example, but dairy faces a slow adoption curve. By comparison, Latin America, where dairy is considered a basic staple, has higher consumption at lower GDP per capita.
Also, many emerging markets have a lower degree of consolidation than those in which the EU and US retailers command less power. These opportunities can be transformed into advantages with the right mix of scale and innovation.
Crafting an international growth strategy
US dairy companies with a presence in international markets will need to pursue a two-pronged strategy to expand their global footprint. The current uncertainty in global trade will force companies to play defense to maintain their position in existing markets. Sixty-three percent of CEOs think that the recent declines in the US industry are structural and not cyclical (Exhibit 9). As a first step, they should systematically and proactively identify risk by developing insights on supply, demand, policy and political factors, and trends.
With this more detailed view of the markets and relevant exogenous factors, executives can build a robust tool kit of financial and demand-hedging tools to manage risk as it occurs. Proactive risk management can enable companies to increase the resilience of their supply chain by collaborating closely with customers and suppliers. Such efforts can help dairy companies develop contingency plans in the event of unforeseen challenges.
At the same time, US dairy companies should take actions to play offense and capture growth in selected global markets. By choosing countries where the United States has trade agreements in place and by making strategic investments, companies can enter markets with long-term dairy deficits. Focusing primarily on export growth in general will not be enough, however, since the US free-trade-agreement network trails that of other countries. US companies can use advanced analytics to pinpoint territories that are a good fit and speed product development and testing. Robust manufacturing and a resilient and geographically diversified supply chain are also critical factors in successful international expansion, so dairy companies should devise long-term strategies for capital, talent, and products.
When companies combine defensive risk management and proactive investment, they can unlock a positive cycle of global growth. However, expansion in the current landscape will also require dairy executives to adopt a different mind-set. An emphasis on agility in core operating systems and innovation can enable products to be developed and introduced to market more rapidly. This capability should be matched with a venture capital approach to investments, in which a series of smaller investments are used to identify promising ideas, introduce a minimum viable product to market, and then scale up based on consumer response.
Core beliefs for success
The Jeeranont has developed a set of core beliefs to succeed in international expansions across different sectors:
Profitability in international markets is strongly affected by end-to-end industry structure (including channels) and barriers to entry. Early due diligence and input from market experts can help companies understand the risks and limitations in a given market.
Having a defined route-to-market strategy (including infrastructure) is critical to winning and influences where companies choose to play.
Economies of scale are crucial in building the relationships, brand, and other capabilities needed for a profitable and sustainable international business. Markets that are still in the early stages of consolidation are good targets for companies that have learned to scale up quickly.
Companies should adopt a market-specific approach that takes into account how consumer needs and perceptions differ in each market. Each market is different, so neglecting to understand and adapt to the preferences of local consumers is a recipe for failure.
International growth gives rise to new uncertainties (for example, regulations, currencies, and import restrictions), so companies must develop new capabilities to manage these risks. The difference between failure and success in international expansions is a company’s ability to learn from its mistakes.
A company’s geographic strategy should be integrated into its overall corporate strategy and culture. Further, resources should be carefully allocated (for example, the decision to infuse talent into other geographies). International strategies must be aligned with a company’s business models and capabilities, since it is challenging to build core capabilities that don’t exist or aren’t supported by the parent company.
Last, developing a successful international strategy requires an evaluation of the following factors:
Category attractiveness. What category matches the company’s value proposition?
Market opportunity. What is a market’s potential versus the risk, to determine the ease of reaching scale and growth.
Fit with capabilities and market dynamics. Are consumer preferences and the market structure compatible with the company’s competences and abilities?
Opportunity and risk assessment. What are the timelines, opportunity size, risks, and resources required to enter a market?
Market entry options. Structure (such as partnership, joint venture, and M&A) as well as the resources required to execute.
Given the shifting landscape and long-term trends, each dairy company must determine the right strategy based on its current capabilities and footprint. At a high level, our analysis suggests that a combination of four strategies offer a path to growth.
Deploy deep consumer-preference analytics to identify and serve pockets of growth.
Reimagine the supply chain, making it more agile and flexible, to serve new demand niches.
Serve demand growth in areas with projected deficits. Depending on specific geographies, the free-trade-agreement network might be the first step in identifying export markets.
When exporting is not a possibility, or if the goal is to maximize long-term value capture or market exposure, investing directly in deficit markets to serve them locally is the way to go.
A rapidly changing consumer and global environment requires a bold new outlook and a growth model that can deliver on this challenge.
Several megatrends may drive the next wave of growth in Indian agriculture. Focusing on a number of investible themes could enhance farmers' incomes and transform their quality of life.
India’s determined pursuit of agricultural self-sufficiency since independence has led the country to have a high-growth agriculture sector today. Despite this, India’s farmers are not faring too well and only a third of all agriculture companies posted a profit in recent years. The government’s recent shift in approach, by adopting the goal of doubling farmer incomes, is a welcome attempt to transform the sector. There is scope for agriculture companies and the government to ride emerging megatrends and successfully be a part of this transformation.
The outlook for Indian agriculture and farmers
Minimally dependent on imports, India’s agriculture sector’s GDP stands at an impressive $262 billion. This is due in great measure to the agribusiness companies which have demonstrated higher growth than several other sectors in the last few decades. Growth in the total return to shareholders in agriculture in the last 10 years is 28 percent, an impressive 17 percent higher growth than that earned by the Indian market.
Around 33 percent of the agriculture companies have generated positive economic profit over 2010 to 2015 (Exhibit 1). These companies have used several strategies to generate value, such as de-risking the business through diversifying geographies, ensuring proximity to customers, and achieving operational excellence to drive profitability.
Recent trends are prompting an increasingly urgent question around the sustainability of value creation in the future. The extreme weather volatility, growing food demand, and wide gap in productivity between India and its closest peers, and the need to manage food prices and import pulses to meet demand have all highlighted that India needs to rethink its approach.
In a significant mindset shift, the government’s focus is moving from increasing farm output to improving farmer incomes—it has set an aspiration to double farmers’ incomes by 2022. This will enhance productivity and have multiplied effects on the larger ecosystem.
Boosting farmer incomes in India
Indian farmers face multiple challenges, primary among these are excessive stress on land, water and soil health, lack of knowledge/information about high value/growth products, limited exposure to high productivity practices, weak market linkages, inefficient supply chains with high levels of food wastage, and an acute dependence on rainfall.
Increased farmer incomes will:
foster the use of mechanized techniques to efficiently use stressed resources
increase farmers’ knowledge of the high productivity practices and high value product choices available to them
help farmers to better navigate market inefficiencies rather than settling for lower prices set by the middlemen
To increase farmer incomes, India needs to adopt a higher value mix of farm output, capture greater value through better storage and processing, and make market mechanisms more efficient for farm inputs, financing, and sale of output. Doing this will require all stakeholders to make bold bets by building partnerships, adopting granular crop and micro-market approaches, and developing new business models. We estimate that such measures could unlock roughly $175 billion of agriculture GDP and increase farmers’ income by 85 percent by 2025 (Exhibit 2).
Understanding the megatrends
While pursuing the objective of doubling farmer income, it is important to keep an eye on the emerging trends in Indian agriculture. These will continue to shape growth and will lead towards the themes for transforming the sector:
Additional food demand of around 400 million tons by 2025: A four-fold growth of the Indian middle class in the last decade, combined with urbanization and higher GDP, have prompted a higher demand for food. If current trends continue, food demand is likely to grow by over 2.5 percent year-on-year over the next 10 years (Exhibit 3).
Shift in consumption toward fruits and vegetables (F&V) and pulses: Unlike the consumption of rice or wheat, which is linearly related to GDP, the consumption of F&V and pulses follows an S-curve relation to GDP (Exhibit 4). Over time, the Indian diet has seen a significant shift to higher protein intake. India is entering a hot zone in this space with projected demand growth at a CAGR of 8 to 11 percent (Exhibit 5).
Stress on supply due to scarcity of resources: India’s farm resources like land, water, and soil health are hugely stressed. More than half the country faces water stress with withdrawals at 40 to 80 percent of available supply. Similarly, the labor supply is stressed too; India’s labor market is making a natural structural transition from farm to non-farm jobs—agricultural jobs declined by 25 million between 2011 and 2015, while non-farm jobs rose by 33 million. The rising wages for farm labor make it imperative to improve farm productivity through mechanization and other measures.
Scope to improve yield: Indian crop yields are still significantly lower than Asian averages (Exhibit 6). For example, the average rice yield in India is 3.6 ton/hectare compared to 6.7 ton/hectare in China. This could improve by at least 40 to 70 percent with suitable interventions. If productivity does not improve, the country could fail to meet the projected food demand for 2025 and remain dependent on imports of rice, pulses, and F&V. To meet the growing demand for pulses, India will need to import around 13 million to 17 million metric tons of pulses by 2025. India would then constitute a very large percentage of global trade volumes in pulses.
Opportunity to cut losses in the food chain: Around 60 percent of food loss and waste in India happens between the field and the end-consumer, and this is concentrated in a few crops (Exhibit 7)—especially F&V and cereals. Several challenges limit cold chain penetration and adoption—high cost of stable power supply, low capacity utilization, and limited financing options. These challenges offer a significant opportunity to improve farmer incomes by addressing the storage and handling of food as well as creating market linkages to customers.
Technological disruption reaching farmers directly: Several companies are using technology to disrupt existing models and directly reach farmers. While technology is helping some companies to strengthen their sales force, others are leveraging it to offer agri-advisory services to the farmers. These include providing weather-related information (e.g., Skymet), integrating mandis (e-NAM), offering agronomic advisory services, and connecting farmers directly to consumers (e.g., farmerfriend.in). These innovations will force incumbents to change their business models, and shift the focus to creating value for farmers and increasing their share-of-wallet.
Successful agricultural transformations: Six core elements of planning and delivery
Tapping seven investible opportunities
All these megatrends help to identify seven investable themes for companies. These could create value and boost farmer incomes.
Invest in F&V and pulses value chain to meet demand: These investments could unlock around $15 billion to $20 billion by 2025 and boost farmer income by 35 percent. The value chain of will grow disruptively (Exhibit 8), with demand concentrated in six crops—mango, tomato, potato, pomegranate, onion, and grapes. By 2025, these six crops will account for around 65 percent of the incremental produce value, through a combination of exports and food processing (Exhibit 9). In pulses, the demand will be driven by a need for packaged and branded pulses, fortified pulses, and the market for ready-to-eat snacks, which is growing at 20 percent CAGR.
Invest in the fast-growing cold chains and cold-storage markets: Despite current challenges, this segment is expected to enjoy significant growth on the back of rising food demand, supply deficits, and improved market economics. The cold chain market is expected to double in size to reach $7 billion to $9 billion by 2020 (Exhibit 10). Cold chain players could invest in alternate energy technologies like solar-powered systems, they can explore chemical treatments to extend the shelf-life of produce, set up pack houses, and reefer transport. They could also optimize the use of existing facilities by opening them up for multiple crops instead of a single crop or product.
Establish market linkages between farmers and buyers: This will establish transparency in pricing and better value, especially for perishable products. It could also help to increase farmer incomes by at least 8 to 10 percent. In addition, it will enable the downstream players to source more effectively by eliminating intermediaries. Farmer–producer organizations (FPOs) are already aggregating supply and supporting farmers towards this goal.
Unlock a large opportunity through digital and analytics: Digitization and analytics will play a critical role in building India’s farms of the future (Exhibit 11). Potential disruptions that could unlock value through the food chain are:
precision farming including integrating field data, weather patterns to drive agronomic advice to farmers, and yield forecasting
efficient farm lending with electronic applications, disbursal of loans, insurance payouts linked to weather, field data, Direct Benefits Transfer in agriculture
universal platform integrating farmers and wholesale markets, to provide timely information for price realization
supply chain management
IoT-based advanced analytics in manufacturing plants to improve availability, throughput, and save costs
commercial excellence in micro-markets, pricing and channel management
Invest in ecosystem partnerships for disruptive solutions: A slew of startups are playing in one part of India’s agriculture value chain to disrupt prevalent business models. In response, larger players could partner with them or incubate their own new businesses. The effort would ultimately result in innovative solutions for farmers.
Enter the agriculture services market: Rising wages, growing awareness of farm mechanization, and easier credit lending to farmers will all boost the market for a shared farm-economy. There is potential to create a marketplace for equipment rentals. Given the small and scattered land holding patterns in Indian agriculture, the services market is bound to increase in the years to come. Such agriculture services will increase the adoption of farm mechanization, which in turn could increase farmer income by around 5 percent.
Offer agriculture financing and crop insurance to strengthen the ecosystem:
Invest in end-to-end value chains, particularly in F&V and pulses, where demand is expected to grow disruptively.
Provide innovative equipment-financing models to farmers through partnerships with manufacturers, weather forecast agencies, and digital partners.
Offer easy financing for FPOs for community infrastructure for storage and transportation.
Create digital ecosystems for financing and crop insurance.
The government’s pivotal role
The government can continue to support businesses to create value in the agriculture sector. In particular, it could enable the shift towards improving farmer incomes through a focus on six crucial areas:
Modernization of farm production, agriculture input markets, storage, and market access to serve local, national, and export demand
Enable portfolio shift towards high value crops through differentiated value chain strategies
Shift in focus from primary production towards processing and retail
Increase in land and labor productivity in agriculture
Greater private-sector engagement
Concrete projects and well-defined performance indicators to track transformation and collaboration between stakeholders.
An incremental agricultural GDP of around $175 billion could help almost double the farmers’ income in the next seven to eight years (Exhibit 12). This will require all stakeholders to tap emerging opportunities. Understanding current megatrends in this context can help to chart a clear course of action towards achieving these aspirations.